3 Chinese Stocks With Rebound Potential

By David Sterman

It's been a tough year for Chinese stocks that trade in the United States. Many of them have sold off -- and stayed cheap --- even as they sport impressive growth rates and low valuations. Thanks to a sharp drop last week on renewed concerns about an overheating economy, these cheap stocks have become even cheaper.

To be sure, the Chinese economy faces hurdles on its path to higher gross domestic product. (Read 5 Landmines for Chinese Stocks in 2011).

Nevertheless, even as investors stay focused on near-term challenges the long-term opportunities remain as robust as ever, a message perhaps lost when you look at the stock charts of many China-based firms, a number of which are now off more than 40% from their 52-week highs.

I've pulled together a short list of beaten-down names. Let's take a closer look at some potential rebound candidates.

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China XD Plastics

China XD Plastics ( CXDC) is the largest supplier of modified plastics to the burgeoning Chinese automotive industry. The company had its first full year of operations in 2007 and is on track to post more than $200 million in sales this year -- a 65% jump from 2009. Yet China XD has soured with investors recently after seeking to sell more shares to raise fresh capital. Shares fell nearly 20% in early October on that announcement and have never recovered.

Serial capital-raising has been a major negative for many Chinese companies as they don't understand U.S. investors' predilection for one-and-done capital-raising. To be fair, that capital raise has a good purpose: The company's manufacturing capacity will increase 35% in 2011. And that should propel per-share earnings from an expected 50 cents this year to more than 80 cents next year despite the recent share dilution. Shares currently trade for less than seven times projected 2011 profits.

The real catalyst for this stock will be management's announcement that cash flow can cover any future expansion plans. For now, shares appear to have found a floor and should move back into favor next year as investors once again focus on the growth dynamics of the robust Chinese auto market.

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China Security & Surveillance

How do you analyze a company that is winning loads of new business but keeps reporting tepid sales? That's the conundrum investors face with China Security & Surveillance ( CSR), which continues to build a massive backlog on the heels of new contract wins. But those contracts are stretched out over an extended period of time, so the company has lagged revenue forecasts for four straight quarters. Sales will likely still grow an impressive 25% this year, but that's half the forecasted growth rate expected earlier in the year.

The third quarter brought more of the same. Sales growth, due to the timing of some contracts, was just 14% from a year earlier, but backlog shot up from $213 million at the end of June to more than $400 million.

China Security & Surveillance is one of the leading suppliers of security gear to companies and governments in China. The company is benefiting from a government-mandated "safe-city" program that seeks to deploy banks of video cameras, traffic management systems and emergency response systems in China's 200 largest cities.

As is the case with China XD Plastics, China Security & Surveillance has soured investors with its serial capital-raising efforts that dilute existing shareholders. The number of shares outstanding shot up from 53 million a year ago to a recent 88 million. That led to a recent 30% quarterly drop in EPS, even though net income was 50% higher than a year ago. Management anticipates only modest growth in shares outstanding next year, which should enable EPS to move toward the $1.15 mark.

Shares trade for just five times that forecast. That multiple won't stay that low in 2011 if management can refrain from diluting shares further and if it can deliver sales results that finally meet or exceed forecasts.

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Deer Consumer Products

Deer Consumer Products ( DEER) makes kitchen appliances for global brands like Stanley Black & Decker ( SWK) and is now ramping up domestic sales by steadily building its brand among Chinese consumers.

I've written about Deer several times before, always noting that the company is a solid grower and nicely profitable. Shares have risen more than 50% since I last visited this stock in August, yet they still look cheap.

Deer announced impressive third-quarter numbers last week, highlighted by a 108% jump in sales and a 125% jump in net income. Thanks to recent contract wins, Deer expects EPS to grow more than 30% in 2011 to around $1.10 to $1.20. Shares trade for around 10 times that view. This remains, in my view, as the best play on the rising Chinese middle class.

Action to Take

China XD Plastics and China Security & Surveillance are extremely cheap because of dilution concerns that should abate. Deer, while not quite as cheap, still looks very undervalued in the context of long-term growth. All three of these stocks look like long-term winners, and should garner more investor appreciation in 2011.

This article originally appeared on StreetAuthority.

At the time of publication, Sterman owned no positions in the stocks mentioned.

This article originally appeared on StreetAuthority, founded in 2001 by industry veterans Lou Betancourt and Paul Tracy. StreetAuthority is a financial research and publishing company with offices in Austin, Texas and Gaithersburg, Maryland. The company aims to help individual investors earn above-average profits by providing a source of independent and unbiased investing ideas.

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